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Bond Index
J.P. Morgan Securities Inc.
December 2004
Overview
The JPMorgan Emerging Markets Bond Index Plus (EMBI+) is our most
liquid US-dollar emerging markets debt benchmark, and tracks total
returns for actively traded external debt instruments in emerging markets.
Included in the EMBI + are US-dollar denominated Brady bonds,
Eurobonds, and traded loans issued by sovereign entities.
The EMBI+ provides investors with a definition of the market for liquid
emerging markets sovereign debt and its traded instruments. It segments
further the universe of emerging markets as defined by the more
comprehensive EMBI Global and EMBI Global Diversified, by placing a
strict liquidity requirement rule for inclusion. Other differences in
inclusion rules apply. (Please refer to the methodology piece EMBI Global
and EMBI Global Diversified: Rules and Methodology for more
information on the EMBI Global/Diversified).
To be deemed an emerging market by the EMBI+, a country must be rated
Baa1/BBB+ or below by Moodys/S&P rating agencies. This criterion,
along with the liquidity ranking rule, carves out a basket of liquid bonds,
each capable of being bought and sold at short notice, and quoted daily by
several market makers at relatively low bid/offer spreads. The EMBI+ is
transparent and timely, representing opportunities available to investors in
this market. It is geared toward managers of index funds who strictly
adhere to the performance and portfolio changes of the index.
Gloria M. Kim
(1-212) 834-4153
gloria.m.kim@jpmorgan.com
The certifying analyst(s) is indicated by the notation AC. See last page of the
report for analyst certification and important legal and regulatory disclosures.
www.morganmarkets.com
EMBI+
EMBI Global
EMBIG Diversified
Rated Baa1/BBB+
or under by
Moodys/S&P
$500 million
$500 million
$500 million
Maturity requirement
for initial entry
Maturity requirement
to maintain inclusion
At least 1 year
until maturity
At least 1 year
until maturity
At least 1 year
until maturity
Country requirements
Instrument requirements
Minimum issue size
Liquidity criteria
No
No
Yes
Includes quasi-sovereigns
No
Yes
Yes
Includes
Latin American USD-denominated sovereign and corporate
bonds
EURO EMBIG/Diversified
Emerging Local Markets Index Plus (ELMI+) Money market instruments within emerging markets
denominated in local currency
Dow Jones CDX.EM
December 2004
Instrument Type
The EMBI+ includes both fixed and floating-rate instruments, as well as
capitalizing/amortizing bonds or loans. Bonds or loans with embedded options
and warrants are eligible for inclusion if a) the options/warrants are attached to
instruments that would otherwise be included in the index and b) the quotation
convention (as recommended by the Emerging Markets Traders Association) is
for instrument prices to be quoted cum options or warrants. Convertible bonds
are not eligible for inclusion into the index.
Issuer type classification
The EMBI+ contains only bonds or loans issued by sovereign entities from
index-eligible countries. Quasi-sovereigns are not eligible for the EMBI+ even
if the entity is 100% owned by the government. Instruments issued by
municipalities or provinces are also not eligible for inclusion.
Instruments will not be eligible for inclusion in the index if their credit has been
improved by a) giving security over commercial receivables or b) giving a
guarantee from a guarantor which is not a subsidiary of the eventual obligor or
the parent company/beneficiary of the issuer of the instrument. For the
purposes of clarification, bonds that are secured in part by US Treasuries (e.g.
Brady bonds) are eligible for inclusion.
Where financing vehicles are used, bonds or loans may be included in the
EMBI+ if either 1) the financing vehicle or bond is guaranteed by an index eligible
issuer or 2) the transaction is structured as a pass-through where the creditor of
the financing vehicle has full recourse to the underlying loan or bond between the
financing vehicle and the final obligor, which itself must be an index eligible issuer.
In order to avoid double counting of index instruments, a bond or loan that is
issued by a financing vehicle is only eligible for inclusion into the EMBI+ if the
underlying loan or bond is not itself included in the index.
Currency denomination
Only those instruments denominated in US dollars are considered for inclusion.
Instruments denominated in US dollars where the amount of coupon or
redemption payment is linked to an exchange rate are not eligible for inclusion.
Prior to 1998, external-currency denominated instruments other than US-dollar, as
well as corporates, were allowed in the EMBI+, but have since then been removed.
Credit rating criteria
Eligible instruments are determined by the rating assigned by Moodys and
S&P to the bonds originating country. Since the EMBI+ covers external-currency
debt, we have defined emerging markets countries according to the ability to repay
external-denominated debt. A country must be rated Baa1/BBB+ or below in
its long-term foreign currency rating for its instruments to enter and remain in the
index. When a country receives a rating of A-/A3 or higher from both Moodys
and S&P, it is dropped from the EMBI+ at the next month-end rebalancing.
Current face amount outstanding
Only issues with current face amount outstanding of $500 million or more will
be considered for inclusion.
December 2004
If an issues current face outstanding falls below this requirement (due to either
a debt retirement by the sovereign or the amortization of principal), the issue
will be removed from the index at the next month-end rebalancing date. The
reverse also holds true. Existing issues that, through reopenings, increase in
size to satisfy our minimum current face outstanding requirement are then
considered for inclusion in the index at the next month-end rebalancing date.
Time until maturity
A bond can only be added to the EMBI+ as long as its remaining life is greater
than 2 1/2 years at the time at which it satisfies our inclusion criteria. Once an
issue is added to the EMBI+, it may remain there up until 12 months prior to
maturity, assuming it continues to meet our inclusion criteria.
An instrument that has been dropped from the EMBI+ is not eligible to re-enter
the EMBI+ for 12 months. Such a step further ensures that the composition of
each index is not subject to temporary liquidity trends.
Legal Jurisdiction
Effective May 31, 2002, inclusion into the EMBI+ is limited to issues with legal
jurisdiction that is domestic to a G7 country. Local law instruments or bonds
that do not fall under G7 jurisdiction are not eligible for the index.
Settlement Criteria
Instruments in the EMBI+ must be able to settle internationally (either through
Euroclear or another institution domiciled outside the issuing country).
Quantifiable source of cash flow return
JPMorgan reserves the right to exclude from the composition of the EMBI+ any
debt instrument that it considers to have a cash flow structure from which
verifiable daily returns or other statistics (i.e. yield, spreads) cannot be calculated.
Liquidity Ranking
Once the eligibility requirements are met, liquidity criteria are applied to the
remaining universe of instruments. We look at three attributes to determine
liquidity ratings: (1) size of the issue, (2) average monthly bid/ask spread, and
(3) number of designated brokers providing daily quotes. The following table
summarizes our liquidity ratings:
Rating
Definition
L1
$2 billion face amount outstanding minimum, average bid/ask spread <= 3/8 point, and quoted by
100% of all designated brokers
L2
$1 billion face amount outstanding minimum, average bid/ask spread < = 3/4 point, and quoted by
at least 1/2 of the designated brokers
L3
$500 million face amount outstanding minimum, average bid/ask spread <= 1 1/2 points, and
quoted by at least 1/4 of the designated brokers
L4
$500 million face amount outstanding minimum, average bid/ask spread <= 3 points, and quoted
by at least 1 designated broker
L5
$500 million face amount outstanding minimum, average bid/ask spread => 3 points, and not
quoted by any designated brokers
December 2004
December 2004
December 2004
maturity buckets
credit ratings
Clients can choose to fix their custom portfolio weights or let it float on a
market-cap weighted basis. Using the JPMorgan Custom Index Builder,
investors can hone in on the specific sectors applicable to their portfolios or
evaluate potential investment scenarios with ease.
December 2004
I. Single-instrument return
The total return on a performing instrument is measured from one trade day to
the next using the following generalized equation:
1.
trt =
FX i, t
FX i, t 1
This equation captures the three main components of a fixed income assets
value: price, cash flow (coupon and/or amortization) and currency. These
components are represented by:
ESVs (t )
C v (t )
December 2004
AM v (t )
FX i, t
Trade date; all index instruments trade on a New York holiday calendar
v(t)
Value date for trade date t; date used to calculate accrued interest,
which usually, but not always, coincides with the settlement date
s(t)
Settlement date for trade date t; date on which cash transaction occurs
where:
ESPs(t )
Effective settlement price, which is the price paid for a bond that is
traded on trade date t and settled on settlement day s(t). The settlement
date is determined by the settlement convention of the bond and
holiday calendar for the settlement convention; in short, the amount of
money, including accrued interest, etc., owed at the settlement date.
xc v (t )
xc v(t) =
C
ds, t
(1 + L t ) 360
December 2004
Lt
ds,t
xamv(t)
xam v(t) =
AM
(1 + L t
ds, t
) 360
10
December 2004
Current Face
Original face
Bradys, Euros,
Moroccan Tranche A
None
For example, a bond that is trading at par but has just amortized 10% would
trade at a price of 100 on a current-face basis, but at a price of 90 on an originalface basis. Also, a bond that is trading at par and has just capitalized 10%
would trade at 100 on a current-face basis and 110 on an original-face basis.
The adjustment from a current-face to an original-face basis is achieved by
using a balance scalar, Bv(t), which keeps track of the remaining balance of a
bond after capitalizations and amortizations. For bonds that have amortized
from par, the balance scalar will be between 0 and 1, starting at 1 at issue and
decreasing to 0 at the final amortization (maturity) of the bond. For bonds that
capitalize, the number rises starting at 1, as determined by the capitalization
rates of the bond. This balance scalar strictly follows the quoting conventions
of a bond and is not necessarily related to the balance of outstanding bonds as
tracked by an issuer.
For example, in the case of bonds that trade with an ex-period for
amortizations, the ex-balance follows the same convention. If the bond goes
ex-amortization 30 days before the coupon, on that date the seller retains the
right to the coupon; therefore, the effective settlement price is lowered (jumps
down) by the amount of the amortization, since the buyer is no longer entitled
to it. For a bond trading on a current-face basis, this adjustment at settlement is
made via the Bv(t) scalar. This scalar is an important variable because it adjusts
other variables affecting the effective settlement price. Accrued interest, for
example, is normally computed on a cash basis (i.e., coupon rate x day count),
ignoring the current balance of the bond. Here, again, the scalar is used to
adjust the accrued interest for the balance on the bond.
Because the balance scalar is determined independently (i.e., it is based solely
on the cash flow structure and quoting conventions for the bond), it can be used
to scale all other variables. The remainder of this description assumes that all
non-price variables have been appropriately adjusted and, therefore, defined on
an original-face basis.
December 2004
11
With these concepts in mind, we can generalize the equation for the effective
settlement price of performing instruments as follows:
3.
ESPs(t) = bp Qt if CO = 1, B v(t) , if CO = 0, 1
+ CO AC v(t) bp Qt + CD AI v(t)
where:
bp Qt
CO
Bv(t)
ACv(t)
CD
Clean/dirty indicator:
1 = Bond quoted on a clean basis; and
0 = Bond quoted on a dirty basis
AIv(t)
12
December 2004
Coupon payment
Depending upon the specific debt instrument, coupons can be scheduled
monthly, quarterly, semiannually, or annually. How the coupon end-of-period
and pay dates are set vary from bond to bond. Several conventions apply to
situations in which the end of a coupons period falls on a weekend or holiday,
as defined by EMTA. These conventions are detailed in Table 4.
Table 4: End-of-period conventions
If a scheduled end-of-period (EOP) date falls on a weekend or holiday, the end of period:
EOP/Pay 1
Remains on that date, and the actual pay date is moved to the next business day.
EOP/Pay 2
And the actual pay date are moved to the next business day.
EOP/Pay 3
And the actual pay date are moved to the next business day, unless that pushes them to the
next calendar month, in which case they are moved to the preceding business day.
EOP/Pay 4
And the actual pay date are moved to the next business day, and all subsequent ends of
periods are benchmarked from that day.
EOP/Pay 5
Coupon accrual
Generally, interest accrues from the previous coupon date (inclusive) to the
settlement date (exclusive). If a bond trades ex-coupon, negative accrued
interest will accrue from the ex-date to the coupon date.
Cash reinvestment
Since coupon income and amortization payments on performing instruments are
reasonably certain, reinvestment is done on the date on which the value date for
the trade captures the next cash payment. This allows the investor to affect the
reinvestment trade such that, when the trade settles, the cash payment is available.
Price and interest return
Price return is the component of total return that follows just the price
movement. Intuitively speaking, it is the original-face, clean-priced bonds
return, Pt(o,c). This bonds return is calculated using variables already defined:
4.
Prt =
PtO,C + AM v(t)
C
PtO,
-1
FX i, t
FX i, t -1
Finally, interest return is simply a residual of total return and price return:
6.
December 2004
1 + irt =
trt + 1
Prt + 1
13
14
December 2004
The total return on day t, TRt, is the arithmetically weighted average of each
instruments return from the period t-1 to t. The weights are marketcapitalization weights from the prior business day, t-1:
7.
TR t =
iL (t' )
i, t', t 1
tri, t
In this equation, the ith bonds dirty market-capitalization weight on day t-1
is defined by:
m i, t', t 1 =
iL (t' )
i, t'
ESVi, s(t 1)
where:
iL (t' )
i, t', t 1
=1
and:
L(t)
t
Ni,t
December 2004
I t = I t -1 (1 + TR t )
The closing cumulative total return index level for the EMBI+ as of the
prior business day (where December 31, 1993 = 100)
15
16
December 2004
Stripped Spread is the value of Z such that market value of portfolio equals
[(CFt)/ (1+ Rt +Z)t]
where
CFt
cashflow at time t
Rt
V. Credit Quality
With the launch of the EMBI Credit Subindices in April 2002, JPMorgan
categorizes and calculates analytics on four distinct credit buckets: Investment
Grade, BB, B and Residual (CCC+ and below) subindex. Where we publish
index statistics for ratings-based subindices, we take the higher of the S&P and
Moodys ratings to determine an instruments ratings category.
December 2004
17
AND
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